A stress test shocker

By Felix Salmon
May 6, 2009

So much for anchoring. You thought BofA might need $10 billion in new capital? Try $35 billion. Or, in English, lots and lots and lots of money — much more money than the bank could conceivably raise privately.

The first obvious question is “if BofA needs $35 billion, how much does Citi need?”. Which leads straight into the question of how much the other 19 banks need, in aggregate — it’s likely to be a shockingly enormous sum.

The second obvious question is “when will Ken Lewis and Vikram Pandit resign?” — I can’t imagine either of them surviving a forced capital injection of this magnitude.

And the third obvious question is “what on earth does Treasury think it’s doing”, leaking the stress tests in such a ham-fisted way, with each iteration worse than the last.

I don’t blame the banks for being angry. They have hundreds of people making sure that they’re well capitalized; Treasury then sends in a handful of wonks to look over the books and a few weeks later determines that they’re off by $35 billion? That’s quite a shortfall, especially when there’s really no indication that Treasury is better at working these things out than the bankers are.

I fear that in the wake of these stress tests, Treasury will have created an atmosphere of antagonism and mistrust which is going to make it almost impossible to push through the kind of root-and-branch regulatory reform that’s desperately needed. Without the banks’ buy-in, no new regulatory structure is going to work — but right now the banks have every incentive to hide things from Treasury and the regulators, rather than to work with them to strengthen the system as a whole. The stress tests might end up improving the banks’ TCE ratios — but that doesn’t mean they will end up improving the health of the financial system as a whole.

Update: There’s been a bit of confusion about what I was trying to say here, so let me clarify: Treasury might well be — and probably is — entirely correct about the amount of capital the banks need. But from the banks’ point of view, that’s not true: they think that Treasury is being too harsh. Which will make them unwilling to cooperate and will create an antagonistic playing field.


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Forget pointing fingers at the Treasury boffins … I’d rather take aim at those upstanding bank-sector executives who have been busily talking up their share prices while sitting on a pile of loan-junk that must be starting to stink. When Ken Lewis recently exclaimed his bank didn’t need any more capital was it an honest appraisal or a job pitch?

Posted by Steve Ellis | Report as abusive

Also worth nothing that the $45 billion in the government put into BoA doesn’t even count as capital for the stress tests. BoA will be fine though. They will sell assets, convert some private preferreds, and never do the government a favor again (taking over Merrill).

Posted by bill | Report as abusive

“[The Banks] have hundreds of people making sure that they’re well capitalized.”

Right Felix. They will be shocked, shocked to be told that excessive risk taking was going on in there!

Posted by Captain Louis Renault | Report as abusive

Please read the entire WSJ before making comment. BAC doesn’t need to raise more capitals unless the bank wants to pay back the 45B from the Government. Ken Lewis was correct when he said BAC doesn’t need anymore government money.

Posted by locintel | Report as abusive

Even if BoA has hundreds of people working on keeping the bank well capitalized, it doesn’t mean that they have enough capital. It felt like an open secret that BoA, Citi, and maybe others may not have been technically solvent, depending on how one did their accounting, even before the stress tests started due to toxic assets, expensive acquisitions, and economic/financial turmoil reducing revenue. If you’re planning for capital requirements to handle higher than expected unemployment or assets that perform more poorly than anticipated, it doesn’t seem like a reach that the best efforts of those hundreds keeping the bank well capitalized (and a few accounting tricks) still won’t fill in a big enough hole.

My question is how much BoA and other banks must acquiesce to capital demands based on conditions that don’t and might not exist. I’m sure they’ll be much more concerned with market reactions and will probably make some attempt at raising the suggested capital without being ordered to, at which point they can say they’re loaded for bear even if they’re hunting squirrel, but how much of the $34 billion (or whatever number eventually comes out) are they being mandated to raise and how soon? Also, how much stress was Treasury using?

Posted by Alexis Nicasio | Report as abusive

You don’t “blame the banks for being angry”?

What are you, a corporate apologist? These banks just about sunk the entire global economy and have sent millions of people into poverty. They ought to immediately go into receivership and broken apart.

Posted by Jade | Report as abusive

Maybe its time we ‘stress test’ the Federal Reserve. Just what is on their balance sheet in the way of ‘toxic assets’. How is their ‘Tier 1′ capital. Would that be the ‘full faith and credit of the US government’? Isn’t that just another name for the American taxpayer. Just how well fixed are those. Lemme see, they’ve lost between 20 and 40% of their net worth, some 9 or 10 million are underwater on their home mortgage a few million more are defaulting on their loans. Personal income down, unemployment up. Who will guarantee the guarantors when a run on the FED begins.

Posted by Scott | Report as abusive

Scott, you want to hold the government accountable while it runs around holding everybody else accountable, using its proven stockpile of expertise in financial matters? That makes no sense to me.

signed – typical American voter

Posted by Russ in PA | Report as abusive

At the bottom of the credit cycle there could well be a need for huge amounts of capital, but as one comes to the top of the cycle and we have a compression on spreads etc this amount of capital will become unsustainable. We need the ability to be able to acccurately judge the a) the range of the business cycle b) the slope of the curve between those two points, especially as the apex is being reached.
If we can do this Ill be very pleasantly surprised

Posted by ron hudson | Report as abusive

I wonder how the banks will get any other boost to their revenues without an additional AIG ‘stimulus’ to pay for the June CDS defaults ??!

The christmas and easter gifts to the shareholders and management is unlikely to be repeated this time, so I wonder what will happen with the 34% rally this time…

after all, a rally in a bull market is nothing else but speculation, in an economy that shows no growth or even stabilisation.

yet again, the greenback will consolidate on demand, imports will drop, china will cut another 1.55 from growth and this to the end of the maturity of the tip of the CDS iceberg….just another 3-4 trillion USD down the line by March 2010, we might – fingers crossed – see an organic growth after a stabilisation (only in the alternative the gov.’s in USA and EU will start structural large projects that will stimulate the real economy, that will create jobs for services and goods that will SELL.


Posted by McChavelli | Report as abusive

$34 billion is 1.5 percent of BAC’s Q1 2009 10-Q assets. I think that is a reasonable amount of new common equity for regulators to require Bank of America to raise by means of either new issues of common stock or preferred for common conversions. Mega banks with too little common equity will make poor lending decisions and put taxpayers at risk of having to bailout those institutions in the future. See my papers http://ssrn.com/abstract=1321666 and http://ssrn.com/abstract=1336288 on this topic.

anyone that puts any merit in a test of any nature completed by the federal government, is beyond hope. the government is leaking what they want to leak on this, they have their agenda set, they want to be running one of these banks, its just a matter of time before we find out which one. Big Brother is alive and well, beware.

Posted by steve | Report as abusive

Dear Felix Salmon (Article Author),
Please take your whiney butt back to your hole int he bank and shut up. You will not find many souls amognst the American public who are willing to trash the only player that is obviously on our side, the Fed. I never, ever thought I would say that, but its people just like you who solidify that resolve. You don’t get it still. These test results are leaked because these banks are still trying to cover up their problems. They still believe that they can survive and return back to the old ways of raping their customers and running home with the cash. You made the bed, now you have to sleep in it and I will NOT shed any tears for you.

Re: Please read the entire WSJ before making comment. BAC doesn’t need to raise more capitals unless the bank wants to pay back the 45B from the Government.

Ok. Done reading. Where does it say that they don’t need to raise more capital? And BTW, your qualification is a huge one. Of course BAC wants to pay back the $45B! They will move mountains (of assets) to avoid a (complete) forced conversion.

Why else would treasury do this but to be heavy handed. They are trying to build their hand so they can justify nationalizing the banks at 10 cents on the dollar. Citi will be the first to fall – as if it hasn’t already. The banks are essentially worthless with no one to lend to except themselves.

Bernanke is also a complete idiot by saying the banks need to ease up on credit so the company can get going again. Obviously no one has any money if this is the case.

Posted by Don | Report as abusive

None professional reporting. It is not accepted to blog on Reuters a judgmental and personal opinion. In fact, this article should have associated numbers and expectations based on earning and economic findings

“Treasury sends in a handful of wonks”?

Um, no. They sent in a bunch of bank examiners from the Fed, OCC, etc. Probably too few, but “wonks” is definitely out of line.

Posted by Carlomagno | Report as abusive

We need to stop exploiting those poor old downtrodden banks

I’ve been reading so many blogs that say what a joke the stress tests are that it’s weird to read this blog post that takes the stress tests seriously. Could you maybe comment on the validity of the stress tests?

Posted by Argel | Report as abusive

“Which will make them unwilling to cooperate”

The banks don’t want to cooperate? Excellent! It was wonderful to work with them. Shut ‘em down THE NEXT DAY. Withdraw all public funding, withdraw the license to perform the function of banking within the borders of the United States.

BANKERS AND REGULATORS SHOULD BE AT ODDS, NOT DRINKING BUDDIES. Bankers at present do not respect anyone or anything. The chain needs to be yanked – hard. This economic collapse is in fact their fault, and they must be blamed for it, whether they like it or not.

Posted by Unsympathetic | Report as abusive